The Basic Financial Statements

One of the central questions in non-profit financial management is: How well does this organization accomplish its mission? From a financial standpoint, one way to answer this question is to determine how much of the organization's expenses are related to its core, mission-related services. In the language of accounting, this distinction is program services vs. support services (i.e., administrative services). According to paragraph 28 of FASB Statement 117, program services are "activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfill the purposes or mission for which the organization exists." Support services are everything else: fund-raising, communications, management, administrative support, and other activities necessary to deliver program services.

Donors want to support a non-profit's primary goals. They want to know if their contribution improved a child's education, fed the hungry, funded scientific research, or advanced objectives outlined in the organization's mission. They are less interested in funding rent, insurance, professional memberships, administrators' salaries (gasp!), or other support services. To be clear, support services are essential. They're just not sexy. That is why one of the most closely watched numbers in non-profit financial management is the program expense ratio, computed as total program service expenses/total expenses. Many donors look for organizations with comparatively high program expense ratios, and many non-profit leaders work hard to minimize their support service expenses for that same reason.

The program services vs. support services distinction is so important that GAAP calls for a fourth basic statement to illustrate it. This statement is called the Statement of Functional Expenses. It shows three basic categories of expenses:

1. Program. Many non-profits report their program expenses separately for each of their major mission or programmatic areas.
2. Management and General are principally salaries and benefits for administrators, technical support services like accounting and information technology, and reconciliation expenses in areas like depreciation.
3. Fundraising includes expenses related to fundraising and special events, identifying and contacting donors, and other expenses associated with soliciting and generating contributions.
   
   

Let's return to Treehouse and examine its Statement of Functional Expenses. Treehouse reports expenses for each of its main programs in the first three columns from the left.

Education programs are by far the largest spending area. In FY 2022, Education programs were $5.6 million, or 23.7 percent of the organization's total expenses. The previously mentioned Treehouse Free Store program expenses were $1.5 million (6.4 percent of total spending), and all "other" programs were $12.5 million (53.1 percent of total expense).

Total expenses in all program services in 2022 were $19.6 million, or 83.3 percent of total spending. In other words, the program service ratio is 83.3 percent. To put it one more way, 83 cents of every dollar Treehouse spends goes directly to fund the organization's core programs.

One appealing feature of the Statement of Functional Expenses is that the expense categories are intuitive. Items like payroll, payroll taxes and benefits, occupancy (i.e., expenses related to maintaining buildings), licenses and fees, and transportation are self-explanatory.

Like many other human services-focused non-profits, most of Treehouse's spending on support services is for fund-raising, and most of its spending on support services overall is for payroll. The same applies to spending on education programs. All these functions are labor-intensive.